Better innovation for better lives

Innovation has always been a foundation of our economies. From the invention of the wheel to the Industrial Revolution, via air transport, the internet and medicines, innovation leads to change, progress, and hope. In today’s world, which is still reeling from the crisis and looking for new, stronger, more inclusive and sustainable ways forward, policies for fostering innovation are more relevant than ever.

Innovation is more than about new products; it is about the creation and diffusion of new processes and methods as well. Innovation can lead to new businesses, new jobs and cleaner environments.

Innovation can be found in several places in the growth statistics of a country. First, there is technological progress embodied in tangible, physical capital, such as better machinery, smarter equipment or greener buildings. Second, there is intangible, knowledge-based, capital, such as software, data, research & development (R&D), design, intellectual property, and firm-specific skills.

Third, there is smarter, more efficient use of labour and capital to generate so-called multi-factor productivity growth (also referred to as total factor productivity). And fourth, there is the role that innovation plays in strengthening the dynamics in the economy, with new innovative firms entering the market, replacing other slower, less innovative ones in a process known as creative destruction. Together, these four dimensions account for as much as half of GDP growth.

Innovation is not just about supporting growth; it is also vital for addressing deep social and global challenges, like ageing, resource scarcity, disease and climate change. Innovation spurs education, skills and wellbeing throughout life too. At the same time, innovation can contribute to inequality, which is why it needs to be accompanied by appropriate labour and social policies.

A toolkit (not just) of things There is no magic wand for fostering innovation; part of the trick is to know when governments should step out of the way and when (and where) they should step in to support the process. Policies are needed domestically, for instance, to ensure a vibrant, open educational and entrepreneurial scene, and reach out globally, too, to draw on knowledge and ideas from around the world. Countries should take a long-term view because returns on fundamental R&D can take decades to materialise, yet without these investments breakthroughs would not occur. Moreover, innovation belongs to no single country, firm, scientific institution or foundation and the innovation map shifts all the time: China recently became the second largest funder of R&D, ahead of the European Union and behind the US.

Today’s world is increasingly shaped by the rise of the digital economy. With billions of people using the internet and mobile communications, knowledge diffusion is accelerating. In countries where literacy remains a challenge, image and voice are connecting communities to global networks. The proliferation of massive amounts of data is just a hint of what can be expected from the emergence of ubiquitous data generation and computing, dubbed the “Internet of Things”. Updating our policies to address this new reality is a priority not only for information and communication policies, but across the board: consumer, trade, taxation, education, transport and more.

While business is the key driver of innovation in advanced economies, government policies are critical, to lay the groundwork and shape the policies that matter. Five priorities are particularly important from the broader toolkit that governments have at their disposal:

1. Strengthen investment in innovation and foster business dynamism In many OECD countries, firms now invest as much in knowledge-based assets as they do in physical capital and such investments have proven to be more resilient during the recent crisis (see chart). But to get more benefit, they should be seen as a bundle, not separate investments. Also, countries should apply reforms that allow capital and labour to flow to productive, knowledge-intensive careers and firms.

Young firms–those five years old and younger–are particularly important, and account for over 45% of all new jobs created in OECD countries over the past decade. They drive renewal and creative destruction in the economy.

The trouble is that policies too often favour incumbents, shoring up the status quo and stifling the experimentation with new ideas, technologies and business models that underpin the success of young firms and limit innovation potential. Policies should not park resources in propping up outdated, inefficient or unproductive firms.

2. Invest in and shape an efficient system of knowledge creation and diffusion Public funding is needed to address the inherent underinvestment in basic research of private firms, as this drives long-run productivity growth and facilitates the adoption of innovations across the economy. Our evidence is clear on this: long-term and stable public research funding is essential for future innovation.

Meanwhile, public support for innovation in the business sector should look for investments that potentially have high social returns, and help foster international co-operation and networks. Detail in policy design and implementation is important and governments should look to each other for experience, inspiration and guidance. For instance, tax incentives for R&D that meet the needs of young, innovative firms by focusing on cash refunds, or the use of tax credits for R&D-related wages, cannot only strengthen innovation, but also help avoid amplifying cross-border tax planning opportunities among larger firms.

3. Seize the opportunities of the digital economy An open and accessible internet, where creativity, sharing, entrepreneurship and experimentation can flourish, is essential for innovation in the 21st century. Big data and data analytics have become a driving force in science, product innovation, processes, organisational methods and services, including healthcare. Policies are needed to promote skills in data analytics, and to foster investments in appropriate infrastructure, including data itself. At the same time, striking the right balance between the free flow of data and safeguarding personal privacy and confidence will require constant attention among policymakers.

4. Foster talent and skills OECD data show that only one-third of workers have the required skills for a technology-rich environment, which raises a major challenge for innovation. Funding for lifelong learning and policies to encourage training are needed to address this. Women in particular should be given every opportunity to participate in science and entrepreneurship and contribute more fully to innovation. Policies should also enable international mobility among highly skilled workers. Though international mobility is a delicate challenge, OECD research shows that in many cases knowledge flows back and forth between countries and regions, enabling many countries to benefit.

5. Improve the governance and implementation of policies for innovation A wide range of government policies affect innovation, which implies that they have to be well-aligned, not only at the level of central government, but also between the central government and regional and local authorities. There is also a need to cooperate with other countries and global institutions, including to help address common global challenges and share the costs of investment in basic research. Monitoring and evaluation of approaches and outcomes will help governments learn from experience and bolster policy performance and adaptability over time.

Not every country can become an innovation leader, and each country has different strengths and weaknesses, but every country can do better at tapping into, and developing, its knowledge-based capital and improving its position along global value chains. The OECD Innovation Strategy 2015 can help.